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Thursday
Aug102017

Sanctions Imposed for E*TRADE Entities’ Self-Reported Record Retention Violations

In In Re E*TRADE Securities LLC and E*TRADE Clearing LLC, No. 17-07 (CFTC Jan. 26, 2017), the U.S. Commodity Future Trading Commission (CFTC) accepted a settlement offer (“Offer”) from E*TRADE Securities LLC and E*TRADE Clearing LLC (collectively “E*TRADE Entities”) regarding self-reported violations of CFTC record retention and supervision requirements. The CFTC found both entities violated supervisory duties and failed to preserve and maintain audit trail logs for customers. As a result, the CFTC mandated future compliance with retention policies and payment of a civil fine.  E*TRADE agreed to enter into the Order without admitting or denying any of the findings or conclusions therein.

According to the Order, the E*TRADE Entities learned as a result of an internal review conducted in January 2014 that they had not preserved certain customer electronic audit trail logs. E*TRADE Securities used a third-party vendor to generate these logs on a monthly basis. The vendor stored each record for a ten-day period and allowed E*TRADE Securities to download and save the information. The vendor informed E*TRADE Securities of this retention policy by email, however, E*TRADE Securities employees did not take additional steps to preserve audit logs.

E*TRADE Securities began downloading information daily from the third-party vendors once it discovered the retention error and attempted to recover the missing log data. In the same time frame, E*TRADE Clearing learned its internal database did not store audit logs automatically. E*TRADE Securities could not recover audit logs from October 2009 through October 2011, and from June 2012 through December 2012. Both companies could not recover audit logs from March 2013 through January 2014. E*TRADE Securities updated its Manual in March 2015 to reflect the record keeping requirements.  Both entities “self-reported” the recordkeeping violations to the CFTC.

Section 4g(a) of the Commodity Exchange Act (CEA), 7 USC §6g(a), requires every person registered as a futures commission merchant (FCM), introducing broker (IB), floor broker, or floor trader to keep books and records available for inspection of transactions, and customer and commodity positions. Similarly, Regulation 1.31, CFR § 1.35(a)(1), mandates that FCMs and IBs keep full and complete records of pertinent data and memorandum of all transactions “relating to its business of dealing in commodity futures.” Under 17 CFR § 1.35(a)(3)(ii), registrants must have written operational procedures to ensure proper electronic document retention. Commission Regulation 166.3, 17 CFR § 166.3 requires registrants to develop deterrent and detection procedures to identify CEA violations. Lastly, according to FC Stone, LLC, CFTC No. 15-21 2015 WL 2066891 (May 1, 2015), registrants must diligently supervise all business activities of its officers, employees, and agents.

The CFTC determined the E*TRADE Entities’ permanent loss of more than three years of records, attributable to a failure to ensure proper record retention, violated both Section 4g(a) of the CEA and Regulations 1.31(a) and 1.35(a). The Order also identified two breaches of Regulation 166.3: the E*TRADE Entities’ failure to implement reliable procedures to retain audit trail logs, and E*TRADE Securities’ failure to address the third-party vendor’s notice regarding retention periods.

For the above reasons, the CFTC directed the E*TRADE Entities to immediately end any record retention violations and ordered payment of a $280,000 civil monetary penalty. The Order recognized the E*TRADE Entities’ cooperation in this matter.

The primary materials for this case may be found on the DU Corporate Governance website.

Wednesday
Jul052017

First Circuit Found Sufficient Evidence to Affirm Insider Trading Conviction

In United States v. Bray, 853 F.3d 18 (1st Cir. 2017), defendant Robert Bray (”Defendant”) appealed his conviction for insider trading. The First Circuit affirmed the jury’s guilty verdict for criminal securities fraud, finding that sufficient evidence supported the jury’s findings and that an error in the jury instructions was inconsequential.

The prosecution alleged Defendant asked for, and received, nonpublic information from Chris O’Neill (“O’Neill”) after stating he needed to make a “big score” to fund a real estate project and asking for any “bank stock tips”. O’Neill, who worked for Eastern Bank (“Eastern”), was performing due diligence on a local bank, Wainwright Bank & Trust Co. (“Wainwright”), a possible acquisition target. After O’Neill provided Wainwright’s name on a napkin, Defendant allegedly purchased a large amount of shares. After Eastern announced the acquisition, Defendant offered O’Neill an opportunity to invest in his real estate project. He ultimately sold the shares, netting approximately $300,000.

Defendant challenged the sufficiency of the prosecution’s evidence that he knew O’Neill breached a fiduciary duty by providing the tip. Specifically, Defendant asserted that O’Neill did not receive a “personal benefit” for providing the information. He also claimed the trial court erred by instructing the jury that it could convict him if he “should have known” O’Neill had an obligation to keep the information confidential. 

The unlawful trading of securities based on material, nonpublic information, or illegal insider trading, violates both Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Individuals trusted with confidential information about a corporation cannot secretly use that information for their personal advantage and must either abstain from trading in that corporation’s securities or disclose the information ahead of time. In “tipping” situations, the person receiving the misappropriated information “inherits” the tipper’s duty to abstain or disclose “’if the tippee knows the information was disclosed in breach of the tipper’s duty’ and ‘may commit securities fraud by trading in disregard of that knowledge.’” To breach a duty, however, the tipper must receive a “personal benefit” as a result of the disclosure. 

With respect to jury instructions, failure to object results in an application of the “plain error” standard. “In order to establish plain error, [Defendant] must show ‘(1) that an error occurred; (2) that the error was clear or obvious; (3) that the error affected his substantial rights; and (4) that the error also seriously impaired the fairness, integrity, or public reputation of judicial proceedings.’”

The court held there was sufficient evidence for a reasonable jury to conclude that Defendant “knew O'Neill tipped him in expectation of a personal benefit.” As the court determined: 

O'Neill and [Defendant’s] close relationship is our starting point: though Bray may not have known the exact benefit O'Neill sought in exchange for the tip, a reasonable jury could have readily inferred O'Neill's intent to benefit [Defendant]. [Defendant’s] actions after Eastern announced the Wainwright acquisition bolster this conclusion. He thanked O'Neill for the tip and, unprompted, offered him an opportunity to invest in the Watertown Project on two separate occasions, the same project for which he requested the tip in the first place. Before this, [Defendant] had never offered O'Neill a similar opportunity and had rarely (if ever) made such offers to anyone else at Oakley. Consequently, the jury was entitled to conclude that [Defendant] knew O'Neill sought a personal benefit in exchange for the tip. (citation omitted) 

The evidence was, therefore, sufficient for a jury to conclude that O’Neill “anticipated a benefit and breached a fiduciary duty to his employer.” 

With respect to the jury instruction, the court found that the lower court “clearly erred.” Nonetheless, “the government presented ample evidence that [Defendant] knew O'Neill had breached a duty of confidentiality by tipping, or at least possessed the requisite ‘culpable intent.’” As a result, “different jury instructions ‘would have been of little help’” to Defendant and, his allegations feel “short of the ‘rather steep’ road to success under the ‘exacting’ plain-error standard.” For the reasons above, the court affirmed the Defendant’s guilty conviction.

The primary materials for this case may be found on the DU Corporate Governance website.

Sunday
Jun252017

Chitwood v. Vertex Pharms: Massachusetts Supreme Judicial Court Provides Guidance on Shareholder Inspection Demands 

In Chitwood v. Vertex Pharms., Inc., 71 N.E.3d 492 (Mass. 2017), the Supreme Judicial Court of Massachusetts vacated the lower court’s decision to dismiss Fred Chitwood’s (“Shareholder”) claim for inspection of corporate records of Vertex Pharmaceuticals, Inc. (“Vertex”).  The Court held that the lower court applied too demanding of a standard and the scope of the demand made by the shareholder far exceeded the authorized scope of inspection under § 16.02 (b).

According to the complaint, Vertex, in the spring of 2012, issued “false and misleading” statements in a press release about the initial study results of the effectiveness of two drugs. Vertex’s stock rose due to the announcement. Three weeks later, Vertex issued a second press release which indicated the drug study did not result in a new medical breakthrough and Vertex’s stock declined. Seven of Vertex’s officers and directors allegedly sold over $37 million in Vertex stock between the first and second announcement.

 Plaintiff sent a letter to Vertex’s board of directors (the “Board”), claiming Vertex officers and directors wrongly engaged in insider trading prior to the second announcement and demanded that the Board initiate a derivative action based on the alleged misconduct. The Board investigated the Shareholder’s allegations and determined there was no breach of fiduciary duty by any officer or director. Shortly thereafter, Shareholder demanded to inspect and copy seven categories of Vertex’s books and records to investigate the actions of the Board. The Board rejected Shareholder’s request, and the Shareholder filed suit to compel inspection of the requested records. After concluding Shareholder failed to sufficiently show “proper purpose,” the trial court dismissed the complaint.

 Under G. L. c. 156D, § 16.02 (b) of the Massachusetts Business Corporation Act (“Act”), a shareholder, upon written notice, is entitled to inspect and copy various categories of corporate records if the shareholder makes the demand “in good faith and for a proper purpose,” and if the particular records sought to be inspected are “directly connected” with that purpose.

The Court rejected the “credible basis” standard used by Delaware courts, concluding that while “modest,” the standard imposed a burden that was “more demanding than is appropriate for the more limited scope of books and records subject to inspection under § 16.02.”  As a result, the Shareholder did not need to provide evidence of wrongdoing beyond “the timing of the press releases and the insider trades” to establish “proper purpose” for demanding records. The Court found the Shareholder had a proper purpose for requesting excerpts from the original meetings of the Board and committee. Therefore, the Court held that the trial court misapplied the “proper purpose” standard of § 16.02.

For the above reasons, the court vacated the judgment of dismissal and remanded the case to the Superior Court for further proceedings.

The primary materials for this case may be found on the DU Corporate Governance website. 

 

Sunday
Jun252017

In Re Hedayati: Cease-and-Desist Proceedings against Nema Hedayati

In In Re Hedayati, Securities Exchange Act Release No. 80238 (admin proc Mar. 14, 2017), the Securities and Exchange Commission (“SEC”) issued an order instituting public administrative and cease-and-desist proceedings against Nima Hedayati (“Hedayati”) for alleged violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder. In anticipation of the proceedings against him, Hedayati submitted, and the SEC accepted, an Offer of Settlement (“Offer”), in which he neither admitted nor denied the allegations.   

According to the SEC’s allegations, Hedayati was an audit staff member employed by Lam Research Corporation’s (“Lam”) independent audit firm. In October 2015, Hedayati, in the course of his employment, acquired material nonpublic information concerning a planned acquisition of KLA-Tencor Corporation (“KLA”) by Lam. Shortly thereafter, Hedayati purchased 20 contracts for out-of-the money KLA call options in his account and an additional 20 KLA call options in the account of his fiancée. Hedayati also advised his mother to trade in KLA stock and, based on his advice, Hedayati’s mother purchased 1,400 shares of KLA common stock. After KLA and Lam announced their merger on October 21, 2015, KLA shares rose nineteen percent. Following the merger announcement, Hedayati liquidated the 40 KLA options, realizing profits of $27,971.59. His mother realized profits of $15,056. 

Rule 10b-5 prohibits any person from employing any device, scheme or artifice to defraud in connection with the purchase or sale of any security. 17 CFR 240.10b-5.  This includes the purchase or sale of a security on the basis of material, nonpublic information about that security, in breach of a duty of confidence that is owed, directly or indirectly, to the issuer of that security.

The SEC determined Hedayati received training on, and was familiar with, his employer’s code of conduct that required him to safeguard confidential client information and prohibited Hedayati “from using that information for his own personal benefit.” The code of conduct specifically prohibited employees from trading on the basis of material, nonpublic information. Additionally, the SEC claimed Hedayati knew the information about the proposed merger was material, nonpublic information. The SEC determined Hedayati knowingly or recklessly breached his duty of trust and confidence to his employer when he traded in KLA options and advised his mother to trade in KLA on the basis of material, nonpublic information. Based on these findings, the SEC charged Hedayati with willfully violating Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

For the above reasons, the SEC determined to accept the Offer from Hedayati and ordered Hedayti to cease-and-desist from committing any further violations of Section 10(b) of the Exchange Act, prohibited him from appearing or practicing before the SEC as an accountant, with a right to seek reinstatement after 5 years, and ordered Hedayati to pay disgorgement of $43,027.59, plus prejudgment interest of $1,269.70, and a civil penalty of $43,027.59.

The primary materials for this case may be found on the DU Corporate Governance website.

Wednesday
Jun212017

No-Action Letter for Ecolab, Inc. Permits Exclusion of Proxy Access Proposal but Denies Deadline Waiver

In Ecolab Inc., 2017 BL 84445 (Mar. 16, 2017), Ecolab Inc. (“Ecolab”) asked the staff of the Securities and Exchange Commission (“SEC”) to permit the omission of a proposal submitted by John Chevedden (“Shareholder”) requesting an increase in the limitation of shareholders from 20 to 50 who can aggregate their shares for purposes of “proxy access.” The SEC issued the requested no action letter, finding “some basis” for exclusion under Rule 14a-8(i)(10).

Shareholder submitted a proposal providing that:

RESOLVED: Shareholders request that our board of directors replace the limit of 20 shareholders who are currently allowed to aggregate their shares to equal 3% of our stock owned continuously for 3-years in order to make use of our shareholder proxy access provisions adopted recently. The 20 shareholder limit is to be increased to a limit of 50 on the number of shareholders who can aggregate their shares for the purpose of shareholder proxy access.

Under current provisions, even if the 20 largest public pension funds were able to aggregate their shares, they would not meet the 3% criteria for a continuous 3-years at most companies examined by the Council of Institutional Investors. Additionally many of the largest investors of major companies are routinely passive investors who would be unlikely to be part of the proxy access shareholder aggregation process.

Under this proposal it is unlikely that the number of shareholders who participate in the aggregation process would reach an unwieldy number due to the rigorous rules our management adopted for a shareholder to qualify as one of the aggregation participants. Plus it is easy for our management to reject an aggregating shareholder because management simply needs to find one of a list of requirements lacking.

Ecolab sought exclusion of the proposal from its proxy materials under subsection (i)(10) of Rule 14a-8.

Rule 14a-8 provides shareholders with the right to insert a proposal in the company’s proxy statement. 17 CFR 240.14a-8. Though the shareholders must meet certain procedural and ownership requirements. In addition, the Rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC.

Rule 14a-8(i)(10) permits a company to exclude a shareholder proposal if the company has already “substantially implemented” the proposal. The SEC has permitted exclusion under this rule when the company’s policies, practices, and procedures compare favorably with the guidelines of the proposal or, alternatively, when a proposal has not been implemented exactly as proposed by the shareholder so long as the company has satisfied the proposal’s essential objective. For additional discussion of the exclusion, see Aren Sharifi, Rule 14a-8(i)(10): How Substantial is “Sub­­stantially” Implemented in the Context of Social Policy Proposals?, 93 Denv. L. Rev. Online 301 (2016).  

Under Rule 14a-8(j)(1), a company intending to exclude a proposal from its proxy materials must file the reasons with the SEC no later than 80 days before filing definitive proxy materials.  The SEC may permit the filing of a submission later than 80 days if the company demonstrates good cause for missing the deadline. For a more detailed discussion of this requirement, see Mark G. Proust, The Evolution of Rule 14a-8(j):  The Good Cause to Clarify Good Cause, 93 Denv. L. Rev. Online 289 (2016).

Ecolab argued Shareholder’s proposal should be excluded under Rule 4a-8(i)(10) because the amended and restated bylaws satisfied the proposal’s essential objective. In December 2015, Ecolab amended and restated its bylaws to adopt a Proxy Access Provision. The Provision permitted a shareholder, or a group of up to 20 shareholders, owning at least 3% stock continuously for at least three years, to nominate and include in the Company's annual meeting proxy materials director candidates constituting up to two individuals or 20% of the Board. Any 20 owners of at least 0.15% of Ecolab’s stock individually, may aggregate their holdings to meet the 3% ownership threshold. Ecolab asserted that its provision provided a meaningful proxy access right to the shareholders, satisfying the Proposal’s objective.

Ecolab also asserted the 80-day limitation set forth in Rule 4a-8(j)(1) should be waived for good cause because Ecolab submitted Proxy Access Aggregation Letters which were posted after the 80-day requirement and therefore Ecolab could not have met the 80-day requirement despite its good faith effort to minimize delay.

The SEC determined Ecolab’s amended and restated bylaws substantially implement the Proposal. As the no action letter stated: “Based on the information you have presented, it appears that Ecolab's policies, practices and procedures compare favorably with the guidelines of the proposal and that Ecolab has, therefore, substantially implemented the proposal.”  Therefore, the SEC did not recommend enforcement action if Ecolab omitted the proposal in reliance on Rule 4a-8(i)(10), however the SEC was unwilling to waive the 80-day requirement of Rule 14a-8(j)(1).

The primary materials for this post may be found on the SEC website.

Sunday
Jun112017

In Re General Motors Co.: SEC Accepts Settlement Offer and Institutes Cease-and-Desist Proceedings

In In Re General Motors Co., S.E.C., No. Admin. Proc. File No. 3-17797 (January 18, 2017), the Securities and Exchange Commission (the “Commission”) instituted a cease-and-desist order pursuant to Section 21C of the Securities and Exchange Act of 1934 (the “Exchange Act”) against General Motors Company (“GM”), and accepted an Offer of Settlement (“Settlement Offer”) from GM in anticipation of the cease-and-desist proceedings.  General Motors submitted the settlement offer “without admitting or denying the findings”. 

As reported by the Commission, GM’s approach to accruing estimated losses associated with vehicle recalls from the period starting in 2012 through the third quarter of 2014, included placing engineering defects recommended for recall on an “Emerging Issues List” (EIL) after review by several internal committees. Once placed on the EIL, the “potential” for a recall was considered “probable and estimable”.  The EIL  was reported to those responsible for the accounting treatment of possible losses related to potential recall actions (the “Warranty Group”).

Beginning in 2012, GM engineers began exploring claims related to a defective ignition switch (the “Defective Switch”) in GM’s line of Chevrolet Cobalts. The Warranty Group was not notified until the fourth quarter of 2013, when the Defective Switch issue finally made the Emerging Issues List. “As a result, from 2012 through the first quarter of 2014, the Warranty Group was not able to consistently consider whether a loss was “reasonably possible” under ASC 450 and for which disclosure was necessary prior to the point at which GM considered the potential field action for an accrual.”

Section 13(b)(2)(B) of the Exchange Act requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that, among other things, transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”). ASC 450 provides guidance for the recognition and disclosure of a loss contingency, and requires issuers to assess the likelihood the future event or events will confirm the loss or impairment of an asset or the incurrence of a liability is “remote”, “reasonably possible”, or “probable”. Upon a determination of probable and estimable, “ASC 450 requires the issuer to accrue the estimated loss.” Where the loss is not subject to a reasonable estimate, disclosure is necessary.

The Commission found GM’s large recall campaigns for the period 2012 through the second quarter of 2014 violated Section 13(b)(2)(B) of the Exchange Act by not devising and maintaining a system of internal accounting controls sufficient to provide reasonable assurances that transactions were recorded as necessary to permit preparation of financial statements in conformity with GAAP.

Accordingly, the Commission, pursuant to 21C of the Exchange Act, ordered GM to cease and desist from committing or causing any further violations of Section 13(b)(2)(B). GM agreed to pay a civil money penalty in the amount of $1,000,000 to settle the proceeding.

The primary materials for this matter can be found on the DU Corporate Governance website.

Sunday
Jun112017

Haque v. Tesla Motors, Inc.: Court Denies Shareholder Request for Company Books and Records

In Haque v. Tesla Motors, Inc., No. 12651-VCS (February 2, 2017), the Delaware Court of Chancery declined shareholder Shahid Haque’s (“Plaintiff”) request to review the corporate books and records of Tesla Motors, Inc. (the “Company”), finding Plaintiff failed to demonstrate a credible basis from which the court could infer possible wrongdoing that would warrant further investigation.

According to the allegations, the Company designs, develops, manufactures, and sells fully electric vehicles and energy storage products. The production of these vehicles presents “complex design, engineering and manufacturing challenges” and is further complicated by a delicate supply chain comprised of more than 350 suppliers around the globe. Performance metrics are tracked in quarterly shareholder letters, including the number of vehicles produced and the number of vehicles delivered by the Company in that quarter.

When its production or deliveries have fallen short of targets, the Company has consistently maintained the “shortfalls are driven by production issues” and “not a lack of consumer demand for its vehicles.” Plaintiff questioned the truthfulness of these representations, and requested the books and records of the Company. After the Company refused to fully comply with Plaintiff’s demand, Plaintiff filed this action to compel the Company to release the relevant records pursuant to Section 220 of the Delaware General Corporation Law (“Section 220”).

“The right to inspect books and records under Section 220 is broad but not unlimited.”   Shareholders bear “the burden of establishing by a preponderance of evidence” that the shareholder: (1) owns stock of the company in question; (2) complied with Section 220 “respecting the form and manner of making a demand for inspection” of the documents; and (3) has a proper purpose. A shareholder also must present some evidence of a credible basis supporting the alleged purpose. 

The court found Plaintiff failed to establish a credible basis for the alleged wrongdoing. Plaintiff’s allegations rested on mathematical speculation based on production numbers disclosed by the Company to shareholders. Plaintiff specifically alleged discrepancies between the number of vehicles the Company could conceivably produce and the number of vehicles the Company actually produced and delivered in each quarter. The court disagreed with Plaintiff’s reasoning and concluded that:  “While some consistency in production levels is to be expected, merely highlighting that average production levels (weekly, monthly, quarterly, etc.) dropped from a prior quarter is not enough to support an inference that Tesla could be fabricating the timing of its vehicle production in order to mislead investors about why it cannot meet its vehicle delivery guidance.”

Accordingly, the court denied Plaintiff’s request to compel the release of Company books and records under Section 220.

The primary materials for this matter can be found on the DU Corporate Governance website.

Sunday
Jun112017

Haque v. Tesla Motors, Inc.: Court Denies Shareholder Request for Company Books and Records

In Haque v. Tesla Motors, Inc., No. 12651-VCS (February 2, 2017), the Delaware Court of Chancery declined shareholder Shahid Haque’s (“Plaintiff”) request to review the corporate books and records of Tesla Motors, Inc. (the “Company”), finding Plaintiff failed to demonstrate a credible basis from which the court could infer possible wrongdoing that would warrant further investigation.

 

According to the allegations, the Company designs, develops, manufactures, and sells fully electric vehicles and energy storage products. The production of these vehicles presents “complex design, engineering and manufacturing challenges” and is further complicated by a delicate supply chain comprised of more than 350 suppliers around the globe. Performance metrics are tracked in quarterly shareholder letters, including the number of vehicles produced and the number of vehicles delivered by the Company in that quarter.

 

When its production or deliveries have fallen short of targets, the Company has consistently maintained the “shortfalls are driven by production issues” and “not a lack of consumer demand for its vehicles.” Plaintiff questioned the truthfulness of these representations, and requested the books and records of the Company. After the Company refused to fully comply with Plaintiff’s demand, Plaintiff filed this action to compel the Company to release the relevant records pursuant to Section 220 of the Delaware General Corporation Law (“Section 220”).

 

“The right to inspect books and records under Section 220 is broad but not unlimited.”   Shareholders bear “the burden of establishing by a preponderance of evidence” that the shareholder: (1) owns stock of the company in question; (2) complied with Section 220 “respecting the form and manner of making a demand for inspection” of the documents; and (3) has a proper purpose. A shareholder also must present some evidence of a credible basis supporting the alleged purpose. 

 

The court found Plaintiff failed to establish a credible basis for the alleged wrongdoing. Plaintiff’s allegations rested on mathematical speculation based on production numbers disclosed by the Company to shareholders. Plaintiff specifically alleged discrepancies between the number of vehicles the Company could conceivably produce and the number of vehicles the Company actually produced and delivered in each quarter. The court disagreed with Plaintiff’s reasoning and concluded that:  “While some consistency in production levels is to be expected, merely highlighting that average production levels (weekly, monthly, quarterly, etc.) dropped from a prior quarter is not enough to support an inference that Tesla could be fabricating the timing of its vehicle production in order to mislead investors about why it cannot meet its vehicle delivery guidance.”

 

Accordingly, the court denied Plaintiff’s request to compel the release of Company books and records under Section 220.

 

The primary materials for this matter can be found on the DU Corporate Governance website.

Tuesday
Jun062017

Time Limited No-Action Position For Failure To Collect And/Or Post Variation Margin 

In Commodity Futures Trading Commission (“CFTC”) Letter No. 17-11, the Division of Swap Dealer and Intermediary Oversight (“DSIO”) of the CFTC, provided general relief from complying with Commission Regulation 23.153 (with a compliance date of March 1, 2017) until September 1, 2017.    DSIO received requests for a transitional relief period for the March 1 requirements from virtually all swap dealers and entities that used swaps to hedge commercial risk. These entities included The Securities Industry and Financial Markets Association’s Asset Management Group, The Investment Adviser Association, The American Council of Life Insurers, and more.

Pursuant to Section 4s(e) of the Commodity Exchange Act (“CEA”), the CFTC is required to promulgate requirements for margin for uncleared swaps applicable to each swap dealer for which there is no “prudential regulator.” As part of this requirement the CFTC created Commission Regulation 23.153, “which requires swap dealers to collect and post variation margin with each counterparty that is a swap dealer, major swap participant, or financial end user.”

The dates for complying with the margin rule were staggered so that swap dealers would come into compliance over a four year period. The first phase affected swap dealers with the largest notional amounts of uncleared swaps and the compliance date for phase one was September 1, 2016.

The swap dealers and their respective trade groups stated they must execute new or amended credit support documentation to settle the variation margin in accordance with the requirements of Regulation 23.153 and, due to the complexity and variation required in these credit agreements, there was not a “one-size-fits all” agreement that works for all market participants. For this and other reasons swap dealers claimed they would not be able to implement the requirements of Regulation 23.153 by the March 1, 2017, deadline without causing substantial disruptions to the uncleared swap market.

The DSIO concluded that a limited delay would serve to preserve the CFTC’s March 1, 2017, implementation commitment, while helping to avoid disruption in the uncleared swap market. Thus, DSIO would not recommend an enforcement action against a swap dealer that does not comply with the requirements prior to September 1, 2017, subject to the following conditions:

1) the swap dealer does not comply with the March 1 requirements with respect to a particular counterparty solely because it has not, despite good faith efforts, completed necessary credit support documentation; 2) the swap dealer uses its best efforts to continue to implement compliance with the March 1 requirements without delay with each counterparty following March 1, 2017; 3) to the extent a swap dealer has existing variation margin arrangements with a counterparty, it must continue to post and collect variation margin with such counterparty in accordance with such arrangements until such time as the swap dealer is able to comply with the March 1 requirements; and 4) no later than September 1, 2017, the swap dealer complies with the March 1 requirements with respect to all swaps to which the March 1 requirements are applicable entered on or after March 1, 2017.

To rely on the protections of the no-action letter swap dealers are expected to make continual, consistent, and quantifiable progress toward compliance with the March 1 requirements.

The primary materials for this no action letter can be found here

Tuesday
Jun062017

William Beaumont Hospital Sys. v. Morgan Stanley: Hospital Fails to Satisfy Heightened Pleading Standard 

In William Beaumont Hospital Sys. v. Morgan Stanley, No. 16-1135 (6th Cir. Jan. 26, 2017), the United States Court of Appeals for the Sixth Circuit affirmed the district court’s dismissal of William Beaumont Hospital System’s (“Plaintiff’) state law fraud claim against Morgan Stanley and Goldman Sachs (collectively “Defendants”) for failing to satisfy the heightened pleading standard of Fed. R. Civ. P. 9(b).

According to the allegations, Plaintiff and Defendants in 2006 entered into a structured debt-issuance agreement for auction-rate securities (“ARS”) to finance renovations of one of its hospitals and for construction of a new facility. Defendants, as underwriters for the debt, agreed to purchase and to make a public offering of the ARS. Pursuant to the agreement and related disclosures, Defendants would submit cover bids in the ARS market to prevent auction failure and reduce costs to Plaintiff. As the “economy slowly deteriorated leading up to the 2008 financial crisis,” a number of different ARS auctions failed.  Banks “began to limit inventory exposure to ARS and discuss ‘exit strategies’ regarding the ARS market.” By early 2008, Defendants stopped submitting cover bids, and while Plaintiff’s auctions never failed, demand decreased, and Plaintiff was “left paying investors a higher-fixed interest rate.”

Plaintiff filed suit against Defendants and subsequently filed arbitration proceedings before FINRA alleging fraudulent misrepresentation. In particular, Plaintiff claimed Defendants: (1) withheld information about the structure of the ARS market and their cover bid practice; (2) misrepresented the availability of rate structures in order to achieve a higher broker-dealer fee; and (3) failed to warn Plaintiff about the failing ARS market. 

In order to successfully plead fraud or misrepresentation in Michigan, a plaintiff must allege:

(1) that the defendant made a material misrepresentation, (2) that was false, (3) that the defendant knew it was false, or was made recklessly without any knowledge of its truth, (4) that the defendant made it with the intention that the plaintiff would act upon it, (5) the plaintiff acted in reliance upon it, and (6) suffered damages. 

Moreover, a plaintiff must satisfy rule 9(b)’s heightened pleading standard, which requires the complaint to contain specific facts of misrepresentation.

First, Plaintiff alleged that if it knew of the structure of the ARS market and Defendants’ cover bid practice, then it would not have signed the agreement. The court was not swayed by this argument because Plaintiff “acknowledged” in its Official Statement that broker-dealers routinely cover auctions to prevent failure, but they are not obligated to do so. The acknowledged statement also noted that “there is no assurance that any one or more Auctions will not fail.”  In light of the specific disclosures made, there was no actionable claim regarding these allegations. 

Next, the court held the allegations pertaining to the rate structure failed to meet the heightened pleading standard. Specifically, the court found the claims involved vague accusations of fraud and misrepresentation rather than the specific, identifiable statements. The court held the complaint completely void of “specific misstatements made at a certain time and place.” 

Finally, although relying on common law theories of fraud and misrepresentation, the court believed plaintiff was attempting “to impose the duties of a financial advisor on [D]efendants.” The court viewed this approach as “misguided.” Moreover, the claims could not withstand the heightened pleading standard because they failed to provide the names of representatives who participated in the conversations and ran the presentations from which Plaintiff’s allegations arose.

For the above reasons, the Sixth Circuit affirmed the district court’s dismissal of Plaintiff’s fraud claim for failure to plead with specific particularity under Rules 12(b)(6) and 9(b). 

The primary materials for this case may be found on the DU Corporate Governance Website

Friday
Apr212017

Aztec Oil & Gas, Inc. v. Fisher: The Issue of Representative Shareholders

In Aztec Oil & Gas, Inc. v. Fisher, 2016 BL 16110 (S.D. Tex. Jan. 21, 2016), third party plaintiffs Frank Fisher (“Fisher”), Robert Sonfield (“Sonfield”), and the Livingston Growth Fund Trust (“Livingston”) by and through Livingston’s only trustee, Robert L. Sonfield, Jr. (“Sonfield Jr.”) (collectively, “Plaintiffs”) brought a third party shareholder derivative suit on behalf of themselves and Aztec Oil & Gas, Inc. (“Aztec Oil”) against third party defendants Jeremy Driver (“Driver”), Kenneth E. Lehrer (“Lehrer”), and Mark Vance (“Vance”) (collectively, “Defendants”) through allegations of breach of fiduciary duty, aiding and abetting breach of fiduciary duty, fraud, waste, concerted action, and conspiracy. The United States District Court for the Southern District of Texas granted Defendants’ motion to dismiss the third party derivative suit pursuant to Fed. R. Civ. P. 23.1 (“Rule 23.1”).

Prior to the third party derivative suit’s commencement, Aztec Oil and Aztec Energy, LLC brought an action against Fisher, Sonfield, Mychal Jefferson (“Jefferson”), Livingston, and International Fluid Dynamics, LLC (“IFD”), a company Fisher owned, alleging violations of federal securities law, breach of fiduciary duty, fraud, aiding and abetting fraud, aiding and abetting breach of fiduciary duty, conspiracy, legal malpractice, and violations of the Texas Deceptive Trade Practices Consumer Protection Act (the “Underlying Action”). While the Underlying Action was pending, Plaintiffs brought the third party derivative suit, which asserted Defendants, while acting as directors and officers of Aztec Oil, participated in conduct antithetical to shareholders. The derivative suit further alleged Aztec Oil failed to compensate IFD for consulting fees and Fisher for salary earned.

Defendants filed a motion to dismiss in response to Plaintiffs’ third-party claims, alleging Plaintiffs did not have standing to bring a derivative suit under Rule 23.1.

Rule 23.1 allows shareholders to bring a derivative action on behalf of a corporation to enforce a right the corporation failed to enforce. As required under Rule 23.1, a court will examine various factors to determine whether a shareholder’s derivative action fairly and adequately represents similarly situated shareholder interests. Among these factors are whether “economic antagonism” exists between the plaintiff and other shareholders, the “relative magnitude” of plaintiff’s interest in the derivative suit compared to its personal interest, and “plaintiff’s vindictiveness towards” other defendants.

Here, the court ruled Sonfield and Sonfield Jr. did not have standing because they were not shareholders of Aztec Oil. The court also found that Fisher and Livingston were not representative shareholders because they were majority shareholders of Aztec Oil and controlled 80% of the votes. The court concluded that the ownership made it "highly likely that Fisher and the entities he controls will pursue Fisher's own interests at the expense of all minority shareholders and evidencing a serious conflict of interests."   

Accordingly, the court granted Defendants’ motion to dismiss for Plaintiffs’ lack of standing.

The primary materials for this case may be found on the DU Corporate Governance website.

Wednesday
Apr192017

No-Action Letter for Equinix, Inc. Allowed Exclusion of Proxy Access Bylaw

In Equinix, Inc., 2016 WL 110889 (April 7, 2016), Equinix, Inc. (“Equinix”) requested the staff of the Securities and Exchange Commission permit the omission of a proposal submitted by John Chevedden (the “Shareholder”) requesting that Equinix adopt a bylaw that allowed for specific proxy access. The SEC agreed to issue a no action letter allowing for the exclusion of the proposal under Rule 14a-8(i)(10).

Shareholder submitted a proposal providing that:

RESOLVED: Shareholders ask our board of directors to adopt, and present for shareholder approval, a “proxy access” bylaw that . . . require the Company to include in proxy materials prepared for a shareholder meeting at which directors are to be elected by name, Disclosure Statement…of any person nominated for election to the board by a shareholder or an unrestricted number of shareholders forming a group that meets [certain criteria].

Equinix sought to exclude the proposal under subsection (i)(10) of Rule 14a-8.

Rule 14a-8 provides shareholders with the right to include a proposal in the company’s proxy statement. 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and eligibility requirements. Moreover, the Rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the requirement of the Rule, see The Shareholder Proposal Rule and the SEC.

Subsection (i)(10) permits a company to omit a proposal if the company has already substantially implemented the proposal. A company meets this standard if its implemented “policies, practices, and procedures compare favorably with the guidelines of the proposal.” The company need not take the exact action requested by the shareholder; it must only implement the proposal’s essential objectives. For a more detailed discussion of this exclusion, see Aren Sharifi, RULE 14A-8(I)(10): HOW SUBSTANTIAL IS “SUBSTANTIALLY” IMPLEMENTED IN THE CONTEXT OF SOCIAL POLICY PROPOSALS?.   

Equinix argued the proposal should be omitted under subsection (i)(10) because it adopted an amendment to its bylaws in March of 2016 that satisfied the proposal’s essential objective of providing shareholders a meaningful proxy access right. Specifically, the amended provision allowed any shareholder owning at least 3% or more of the company’s stock continuously for at least three years to nominate candidates for election up to the greater of (1) two candidates, or (2) 20% of our Board, to be included in Equinix’s proxy materials. Equinix believed the proxy access provision in its bylaws compared favorably to, and addressed, the essential objective of the proposal.

The SEC agreed and concluded it would not recommend enforcement action to the Commission if Equinix omitted the proposal from its proxy materials in reliance on subsection (i)(10). The SEC noted the Company’s “board has adopted a proxy access bylaw that addresses the proposal’s essential objective.”

The primary materials for this case may be found on the SEC Website.

Monday
Apr172017

No-Action Letter for Procter & Gamble Company Denied Exclusion of LGBT Discrimination Policies Proposal

In Proctor & Gamble Co., 2016 BL 271869, (Aug. 16, 2016), Procter & Gamble Co. (“P&G”) asked the staff of the Securities and Exchange Commission (“SEC”) to permit the omission of a proposal submitted by NorthStar Asset Management, Inc. Funded Pension Plan (the “Shareholders”) requesting a report on the risks and costs to P&G caused by “enacted or proposed state policies supporting discrimination against LGBT people”, and strategies to protect its LGBT employees. The SEC declined to issue the requested no action letter, concluding P&G could not exclude the proposal under Rule 14a-8(i)(3) and Rule 14a-8(i)(7).

Shareholders submitted a proposal providing that:

RESOLVED, shareholders request that P&G issue a public report by April 1, 2017, detailing the known and potential risks and costs to P&G caused by any enacted or proposed state policies supporting discrimination against LGBT people, and detailing strategies above and beyond litigation or legal compliance that P&G may deploy to defend its LGBT employees and their families against discrimination and harassment that is encouraged or enabled by these policies.

P&G sought to exclude the proposal under subsections (i)(3) and (i)(7) of Rule 14a-8.

Rule 14a-8 provides shareholders with the right to insert a proposal in an issuer’s proxy statement. 17 CFR 240.14a-8. The shareholder, however, must meet certain procedural and ownership requirements. In addition, the Rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC.

Rule 14a-8(i)(3) permits the exclusion of proposals that are contrary to any of the SEC’s proxy rules or regulations. The subsection applies to proposals that may be inconsistent with Rule 14a-9, which prohibits materially false or misleading statements in proxy soliciting materials. This subsection permits the exclusion of proposals that are vague and indefinite, rendering the company’s duties and obligations unclear.

Additionally, Rule 14a-8(i)(7) permits the exclusion of proposals that relate to the company’s “ordinary business operations”, including the company’s litigation strategy and legal compliance. “Ordinary business” refers to those issues that are fundamental to management’s ability to run the company on a day-to-day basis. As such, “ordinary business” issues cannot practically be subject to direct shareholder oversight.  For a more detailed discussion of this exclusion, see Adrien Anderson, The Policy of Determining Significant Policy under Rule 14a-8(i)(7)  and Megan Livingston, The “Unordinary Business” Exclusion and Changes to Board Structure

P&G argued the proposal should be excluded under subsection (i)(7) because the scope of the proposal extended into ordinary business matters. While it acknowledged the proposal involved discrimination concerns, P& G argued the proposal also encompassed matters fundamental to its day-to-day business. Specifically, P&G asserted the proposal and its supporting statement relates to hiring and workplace practices, litigation risks, and location of operations, all of which are ordinary business matters.

The Shareholders disagreed and contended the proposal addressed a significant policy issue – LGBT discrimination policies. They argued the proposal did not attempt to “micro-manage” P&G operations by prescribing specific actions, but only sought reporting and analyses on relevant issues. The Shareholder further argued state LGBT discrimination policies have a clear nexus to P&G because it has operations in states with discriminatory laws.

P&G also argued the proposal should be excludable under subsection (i)(3) because the language of the proposal was ambiguous and vague. Specifically, the proposal did not define or explain exactly which policies P&G must consider. P&G questioned whether the proposal meant P&G to report on policies that form an “outright attack” on the LGBT community, or those policies that may not directly address LGBT rights, but could conceivably lead to policies that impact these rights in the future.

In response, the Shareholders argued the proposal was neither vague nor indefinite. They contended the inclusion of bills that may impact future LGBT rights in the proposal presented no problematic ambiguity in the scope of the report. The Shareholders also argued the proposal language clearly calls for disclosure of the impact of both proposed and enacted policies.

The SEC agreed with Shareholders that the proposal was not excludable under either subsection (i)(3) or (i)(7). The SEC noted the proposal was not “so inherently vague or indefinite” that P&G would not be able to determine what actions it must take to implement the proposal. In addition, the SEC noted the proposal did not relate to the company’s ordinary business operations under (i)(7).

The primary materials for this post can be found on the SEC Website.

Wednesday
Apr122017

Loeza v. Doe et al.: Second Circuit Dismisses ERISA Complaint for Failure to Allege Preventing Harm Would Not Cause "More Harm Than Good."

In Loeza v. Doe et al., No. 16-222-cv, 2016 BL 292694 (2d Cir. Sept. 08, 2016), the United States Court of Appeals for the Second District dismissed the putative class action of current and former employees (“Plaintiffs”) of JPMorgan Chase & Co. ("JPMorgan"). The court found that the Complaint failed to plausibly allege that the named fiduciaries (“Defendants”) of the JPMorgan 401(k) Savings Plan (the "Plan") breached the duty of prudence owed to Plan participants under the Employee Retirement Income Security Act ("ERISA").

According to the allegations, Plaintiffs participated in the Plan and invested portions of their retirement in the JPMorgan Common Stock Fund (the "Fund").  The Fund primarily invested in JP Morgan Stock and, as a result, fell under ERISA. Plaintiffs alleged that defendants-appellees Douglas Braunstein and James Wilmot should have prevented the Fund from purchasing JPMorgan stock at an inflated price because they knew the firm's Chief Investment Officer (the "CIO") had taken risky trading positions and helped circumvent JPMorgan's internal risk controls. Braunstein and Wilmot allegedly could have discharged their duty of prudence and prevented harm to the Fund by either freezing its purchases of JPMorgan stock or through public disclosure as required under federal securities laws. According to Plaintiffs, by allowing the fraud to continue, Braunstein and Wilmot created a “more painful” stock price correction, and therefore increased the amount of harm to Plan participants, allegedly causing JPMorgan's stock price to fall by approximately 16% in one day. The Plaintiffs argue that the remedial measures would not have caused the Fund “more harm than good.”

ERISA requires the fiduciaries of a pension plan to act prudently in managing the plan's assets. Fifth Third Bancorp establishes new pleading standards regarding ERISA fiduciaries breaching their duty of prudence.  134 S. Ct. 2459 (2015).  To state a claim for breach of the duty of prudence, a complaint must plausibly allege a legal alternative action that the defendant could have taken that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than benefit it.

The district court granted Defendants' motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) for failing to allege that the challenged actions would cause the Fund “more harm than good.” The court reviewed the district court's decision de novo to determine whether the Complaint satisfied the "more harm than good" prong of Fifth Third Bancorp.

The U.S. Court of Appeals for the Second District affirmed the district court's judgment, finding the allegations “wholly conclusory and materially indistinguishable from the allegations that the Supreme Court found insufficient” in Amgen Inc. v. Harris, 136 S.Ct. 758 (2016). 

The primary material for this case can be found on the DU Corporate Governance Website.

Monday
Apr102017

IBM’s Motion to Dismiss ERISA Claims Granted

This post is the one of two posts discussing claims brought against International Business Machines Corporation (“IBM”) in 2016 regarding a seventeen percent drop in the company’s stock price. This post will specifically focus on claims brought pursuant to the Employee Retirement Income Security Act (“ERISA”). The other post covers claims brought pursuant to federal securities laws.

In Jander v. International Business Machines Corp., No. 15cv3781, 2016 BL 291159 (S.D.N.Y. Sept. 7, 2016), the United States District Court for the Southern District of New York granted IBM’s motion to dismiss for failure to state a claim pursuant to Fed. R. Civ. P. 12(b)(6) with leave to amend Larry W. Jander’s and Richard J. Waksman’s (together, “Plaintiffs”) Amended Complaint.

On behalf of participants in IBM’s 401(k) Plus Plan (the “Plan”), who invested in the IBM Company Stock Fund (the “Fund”) between January 21, 2014, and October 20, 2014, Plaintiffs brought claims against IBM and the Retirement Plans Committee of IBM, including IBM’s Chief Accounting Officer, Richard Carroll, IBM’s Chief Financial Officer, Martin Schroeter, and IBM’s General Counsel, Richard Weber (collectively, “Defendants”) pursuant to Section 502 of ERISA. The Plan permitted employees to defer compensation into various investment options, including the Fund, which was predominately invested in IBM common stock. As members of the Retirement Plans Committees, Defendants Schroeter and Weber were named as fiduciaries under ERISA. Defendant Carroll, as the Plan Administrator, was also named as a fiduciary.

In their Amended Complaint, Plaintiffs alleged that IBM’s stock price was overvalued and dropped approximately 17% as a result of the company’s divestiture announcement. Specifically, in October 2014, the company announced it was transferring its microelectronics business to another company and, consequently, it was taking a $2.4 billion write-down. Additionally, the company announced disappointing third-quarter results. Moreover, in two separate pending cases, allegations that Generally Accepted Accounting Principles (“GAAP”) required the company to record an earlier impairment of its microelectronics assets were asserted.

Defendants moved to dismiss Plaintiffs’ Amended Complaint for failure to state a claim on which relief can be granted arguing the following: (1) Plaintiffs failed to plead the microelectronics assets were impaired; (2) IBM was not a fiduciary; (3) Plaintiffs’ alternative actions assertion failed to meet the requisite standard; and (4) Plaintiffs’ duty to monitor claim was derivative of the underlying claims.

Under ERISA, fiduciaries must “‘act in a prudent manner under the circumstances then prevailing,’ a standard that eschews hindsight and focuses instead on the ‘extent to which plan fiduciaries at a given point in time reasonably could have predicted the outcome that followed.’” In an ERISA action where a GAAP violation is alleged, the higher pleading standard required by Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act regarding scienter are not applicable. As such, the court concluded Plaintiffs’ allegations that the fiduciaries knew the company’s stock price was inflated by undisclosed material facts regarding its microelectronics business plausibly suggested an impairment and, thus, a violation of GAAP.

A threshold question in ERISA cases, however, is whether each defendant acted as a fiduciary of the plan. In addition to named fiduciaries, those who exercise “discretionary control or authority over the plan’s management, administration, or assets” are deemed de facto fiduciaries. The court reasoned that Plaintiffs’ allegations IBM was a de facto fiduciary because it had ultimate oversight over the Plan were bare legal conclusions and, therefore, failed to adequately allege that IBM was a fiduciary.

In cases in which fiduciaries allegedly “behaved imprudently by failing to act on the basis of nonpublic information that was available to them because they were . . . insiders,” pleading a breach of the duty of prudence requires a plaintiff to plausibly allege: (1) “‘an alternative action that the defendant could have taken that would have been consistent with the securities laws,’ and (2) ‘that a prudent fiduciary in the same circumstances [as Defendants] would not have viewed [the alternative action] as more likely to harm the fund than to help it.’”

First, the court determined, as Plaintiffs asserted, Defendants could have issued corrected statements regarding the valuation of the company’s microelectronics business while complying with the federal securities laws. Regarding the second prong, however, the court concluded the company could not reasonably be expected to disclose insider information or halt the Plan from further investing in the company’s stock as Plaintiffs asserted. In so finding, the court reasoned that a prudent fiduciary in Defendants’ circumstances would not have believed that such conduct would be more likely to help rather than harm the Fund.

Lastly, the court held Plaintiffs failed to adequately plead a claim for breach of duty to monitor because such claim was derivative of their claims for breach of duty of prudence, which they failed to sufficiently allege.

Accordingly, the court dismissed Plaintiffs’ claims brought pursuant to ERISA without prejudice and allowed Plaintiffs to file a Second Amended Complaint within thirty days.

Primary materials for this case may be found on the DU Corporate Governance website.

Wednesday
Apr052017

Geier v. Mozido: Motion to Dismiss Granted 

In Geier v. Mozido, No. 10931-VCS 2016 BL 321867, (Del. Ch. Sept. 29, 2016), the Court of Chancery of Delaware granted Mozido, LLC’s (“Mozido”) motion to dismiss Philip H. Geier’s (“Plaintiff”) breach of contract complaint against Mozido.  The court found that Plaintiff failed to state a claim for breach of contract under Court of Chancery Ruel 12(b)(6), as he released all claims asserted in this actions as part of a previous settlement. 

According to the allegations, representatives of Mozido had asked Plaintiff multiple times to join Mozido’s Board of Directors (the “Board”).  In March 2012, Plaintiff agreed to join the Board in exchange for 1% of the then issued and outstanding membership units in Mozido (the “Options”).  Plaintiff served on the Board until his resignation in May 2013.  In July 2012, Modizo needed to raise capital, and Plaintiff had the Philip H. Geier Irrevocable Trust (the “Geier Irrevocable Trust”) and The Geier Group, LLC (the “Geier Group”) loan $3 million to Mozido. Upon default of the note, the Geier Group and the Geier Irrevocable Trust sought action against Mozido and members of the Board who had guaranteed the loan. 

In November 2013, a General Release agreement was executed.  Geier Irrevocable Trust and Geier Group were named releasors, and the agreement contained a carve out claim for any claims by Plaintiff with respect to the Options.  Plaintiff alleged he demanded that Mozido issue his Options and was not able to exercise the Options since his departure from the Board.  Plaintiff, however, only made a formal demand to exercise the Options in October 2014. 

Plaintiff alleged the General Release was inapplicable to the claims regarding the Options.  He asserted that the release should not apply to him because it related only to claims arising from the $3 million loan of the Geier Trust and the Geier Group.  Alternatively, he was not “an intended releaser”. 

A motion to dismiss under Rule 12(b)(6) should be denied if a plaintiff “could recover under any reasonably conceivable set of circumstances susceptible of proof.”  Therefore, Plaintiff must sufficiently prove he can recover the Options with the court assuming the truth of all well-pled facts in the complaint and drawing reasonable inferences in Plaintiff’s favor. 

The court found that the General Release agreement extended to Plaintiff as an individual and released his claims against Mozido related to the Options.  The court first evaluated the General Release itself, and found when the language of the release was clear and unambiguous.  In addition, the court declined to read the General Release in conjunction with the settlement.  Instead, “[t]he General Release must be interpreted within its four corners.” As for the contention that Plaintiff was not subject to the release, the court concluded that he controlled the Geier Irrevocable Trust and the Geier Group.  Moreover, even if he did not, he constituted an “affiliate” and was therefore covered by the General Release. 

For the above reasons, the Court of Chancery of Delaware granted Mozido’s motion, dismissing Plaintiff’s claim. 

The primary material for this case may be found on the DU Corporate Governance website.

Monday
Apr032017

No-Action Letter for Microsoft Permitted Exclusion of Vague Shareholder Voting Proposal.

In Microsoft Corp., 2016 BL 339357 (Oct. 7, 2016), Microsoft Corporation (“Microsoft”) asked the staff of the Securities and Exchange Commission (“SEC”) to permit omission of a proposal submitted by Kenneth Steiner (“Shareholder”) requesting that the board “not take any action whose primary purpose is to prevent the effectiveness of shareholder vote without a compelling justification for such action.” The SEC agreed to issue a no action letter allowing for the exclusion of the proposal under Rule 14a-8(a)(3).

Shareholder submitted a proposal providing that:

RESOLVED, the board shall not take any action whose primary purpose is to prevent the effectiveness of shareholder vote without a compelling justification for such action.

Microsoft sought exclusion under subsections (a), (i)(3) and (i)(7) of Rule 14a-8.

Rule 14a-8 provides shareholders with the right to insert a proposal in the company’s proxy statement. 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements. In addition, the Rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC.

Rule 14a-8(a) permits exclusion of shareholder proposals that “seek no specific action, but merely purport to express shareholder views.” Proposals that do not request specific action it the future, but act prophylactically, are subsequently excluded.

Rule 14a-8(i)(3) permits the exclusion of proposals or supporting statements that are contrary to any of the SEC’s proxy rules or regulations. The subsection applies to proposals that may be inconsistent with Rule 14a-9, which prohibits materially false or misleading statements. 17 CFR 240.14a-9. In addition, this subsection permits the exclusion of proposals that are vague and indefinite, rendering the company’s duties and obligations unclear.  

Rule 14a-8(i)(7) permits the exclusion of proposals that relate to a company’s “ordinary business” operations. This section understands “ordinary business” to mean the issues that are fundamental to a company’s management abilities on a daily basis. Thus, proposals dealing with issues relating to ordinary business are not subjected to shareholder oversight. For additional explanation of this exclusion, see Megan Livingston, The “Unordinary Business” Exclusion and Changes to Board Structure, and Adrien Anderson, The Policy of Determining Significant Policy under Rule 14a-8(i)(7).

Microsoft argued the proposal should be excluded under subsection (a) because the proposal was not a proposal for the purposes of Rule 14a-8. The proposal did not request that the board take a specific action in the future. Instead, the proposal only “directs the board to decline to take action.” Thus, the proposal does not seek any specific action and may be excluded under Rule 14a-8(a).  

Microsoft further argued the proposal should be excluded under subsection (i)(3) because the proposal was impermissibly vague and indefinite. Specifically, Microsoft argued the proposal was so vague that “neither the company nor its shareholder can determine what types of conduct the Submission is intended to address.”

Finally, Microsoft asserted the proposal should be excluded under subsection (i)(7) because the proposal related to the Company’s ordinary business operations. Even if there were board actions in the proposal that may implicate social policy issues, the proposal encompassed activities regarding the company’s interactions with shareholders, which relates to its ordinary business operations.

In response, Shareholder argued the board of directors undermined the shareholder franchise (i.e. adopting complex notices, requiring long forms that often demand proprietary information to the board, etc.), which results in deterred shareholder votes and costly litigation to Microsoft.

The SEC agreed with Microsoft’s reasoning, and concluded it would not recommend enforcement action if Microsoft omits the proposal from its proxy materials in reliance on Rule 14a-8(i)(3). The staff noted “neither shareholders nor the company would be able to determine with any reasonable certainty exactly what actions or measures the proposal requires.” The staff did not address Microsoft’s alternative bases for omission.

The primary materials for this post can be found on the SEC website.

Monday
Apr032017

Janvey v. Golf Channel: Objective Value Provided Prevails Over Ponzi Claims

In Janvey v. Golf Channel, Inc., No. 13-11305, 2016 BL 272349 (5th Cir. Aug. 22, 2016), the United States Court of Appeals for the Fifth Circuit affirmed the district court’s decision denying summary judgment to Janvey, the court-appointed receiver for Stanford International Bank, (“Plaintiff”) and granting summary judgment to Golf Channel (“Defendant”) allowing Golf Channel to retain the $5.9 million paid by Stanford International Bank for advertising services.

According to the allegations, the Golf Channel had an advertising contract with Stanford International Bank worth over $5.9M. After the SEC exposed Stanford International Bank’s Ponzi scheme, the court appointed a receiver, Janvey, to recover fraudulent transfers.  Janvey contended, relying on the Texas Uniform Fraudulent Transfer Act (“TUFTA”), that the payments made to Golf Channel did not benefit the investors or creditors, even though the advertising services would be “valuable” to another business. The district court granted Golf Channel’s motion for summary judgment based on its interpretation of TUFTA and the affirmative defense by the Golf Channel that the payments received were “in good faith and for a reasonably equivalent value.” Under TUFTA, a creditor can recover transfers made with the intent to defraud unless the transferee establishes that the transfers were received in good faith and for reasonable equivalent value. The Supreme Court of Texas certified that the inquiry of “value” under TUFTA does not depend on whether the debtor was operating a Ponzi scheme, but whether “the services would have been available to another buyer at market rates.” Other states’ fraudulent transfer laws and section 548(c) of the Bankruptcy Code examine “the degree to which the transferor’s net wealth is preserved,” but TUFTA does not.

In early 2015, the Fifth Circuit initially reversed the district court’s judgment, based on its interpretation of TUFTA finding that “the payments to Golf Channel were not for “value” because Golf Channel’s advertising services could only have depleted the value of the Stanford estate and thus did not benefit Stanford’s creditors.”  In response to the Golf Channel’s petition for rehearing, the court certified a question to the Texas Supreme Court on what constitutes “value.”  The Texas Supreme Court reasoned that the Golf Channel’s advertising had objective “value and utility from a reasonable creditor’s perspective at the time of the transaction, regardless of Stanford’s financial solvency at the time.” Janvey v. Golf Channel, Inc., 487 S.W.3d 560 (Tex. 2016).

Based on the opinion from the Texas Supreme Court, the appeals court affirmed the district court’s judgment for the Defendant.

The primary materials for this case may be found on the DU Corporate Governance website.

Monday
Apr032017

Holtz v. JPMorgan Chase Bank: Court Affirms Motion to Dismiss Under SLUSA

In Holtz v. JPMorgan Chase Bank, N.A., 846 F.3d 928 (7th Cir. 2017), the United States Court of Appeals for the Seventh Circuit affirmed the district court’s ruling granting JPMorgan Chase Bank (“JPMorgan Chase”) and all its affiliates motion to dismiss under the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). The Seventh Circuit held Patricia Holtz (“Plaintiff”) and a group of similarly situated investors could not invoke state contract and fiduciary principles to bring a suit under the Class Action Fairness Act, since her claim rested on an “omission of material fact” and thus SLUSA preempted.

The complaint alleged that JPMorgan Chase “proclaim[ed]” on its website to make investment recommendations on the basis of the clients’ best interest.  As Plaintiff alleged, JPMorgan Chase gave its employees incentives to place clients’ money in the banks own mutual funds, even when those funds had higher fees or lower returns than competing funds sponsored by third parties. Plaintiff maintained JP Morgan Chase “violated its promises and its fiduciary duties by inducing its investment advisers to make recommendations in the Bank's interest rather than the clients”. 

Plaintiff filled suit under the Class Action Fairness Act.  Seeking to avoid invoking federal law, Plaintiff framed her claim entirely under state contract and fiduciary principles. Plaintiff asserted that JPMorgan “failed to provide the independent research, financial advice, and due diligence required by the parties’ contract and their fiduciary relationship.”

Where the plaintiff alleges “a misrepresentation or omission of material fact in connection with the purchase or sale” of a security, the claim must  proceed exclusively under the federal securities laws. The purpose of the SLUSA is to prevent persons injured by securities transactions from engaging in “artful pleading or forum shopping” in order to evade the limits prescribed to securities litigation.

Noting that mutual funds were securities, the Seventh Circuit quickly characterized the matter as a “covered class action” for purposes of the SLUSA.   Plaintiff, however, argued that SLUSA did not apply because the claim was not based upon false statements or omissions. The court, however, concluded that the suite depended upon the “assertion that the Bank concealed the incentives it gave its employees.”  As a result, nondisclosure was “a linchpin of this suit no matter how [Plaintiff] chose to frame the pleading.” Nor did the absence of allegations of scienter change the result.  “Every other circuit that has addressed the question likewise has held that a plaintiff cannot sidestep SLUSA by omitting allegations of scienter or reliance.

The court also expressed unwillingness to treat contract claims involving securities as somehow taking the claim outside of SLUSA.  Such an approach would “[a]llow[] plaintiffs to avoid [SLUSA] by contending that they have ‘contract’ claims about securities, rather than ‘securities’ claims” thereby rendering SLUSA “ineffectual, because almost all federal securities suits could be recharacterized as contract suits about the securities involved.”

The court also found that the claims occurred “in connection with” the purchase or sale of a covered security. The alleged omissions were made in connection with an impeding investment decision, rather than with a record-keeping decision. Finally, SLUSA did allow for state law claims in which the misrepresentation or omissions were not material to the transaction, but Plaintiff did not argue JPMorgan Chase’s incentives to its employees were too small to be “material” under the statute.

Accordingly, the Seventh Circuit affirmed the District Court’s ruling granting JPMorgan’s motion to dismiss. Dismissal did not, however, mean that the case could not be maintained elsewhere.  As the court reasoned:

If she wants to pursue a contract or fiduciary-duty claim under state law, she has only to proceed in the usual way: one litigant against another. The Litigation Act is limited to “covered class actions,” which means that Holtz could litigate for herself and as many as 49 other customers.  What she can't do is litigate as representative of 50 or more other persons when the suit involves “a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security”. If the Bank did wrong by its customers, the SEC could file its own suit (or open an administrative proceeding) without regard to the Litigation Act—and the Commission sometimes can obtain relief without showing scienter. What's more, states and their subdivisions can litigate in state court; the Litigation Act exempts them.  Thus there are plenty of ways to bring wrongdoers to account—but a class action that springs from lies or material omissions in connection with federally regulated securities is not among them. (citations omitted). 

The primary material for this case may be found on the DU Corporate Governance Website

Sunday
Apr022017

No-Action Letter for International Business Machines Corp. Allowed Exclusion of Proposal Requesting Resignation of the Company’s Chief Executive Officer.

In International Business Machines Corp., 2016 BL 382928 (Nov. 16, 2016), International Business Machines Corporation (“IBM”) asked the staff of the Securities and Exchange Commission (“SEC”) to permit omission of a proposal submitted by shareholder, Joseph B. Tadjer (“Shareholder”) requesting the resignation of IBM’s current Chief Executive Officer, Virginia Rometty (“Rometty”). The SEC agreed to issue a no action letter allowing IBM to exclude the proposal under Rule 14a-8(i)(7).  

Shareholder submitted a proposal providing that: 

RESOLVED, I proposed, in the form of a nonbinding resolution, that Virginia Rometty resign her position as chief executive officer of the Company as soon as is practical and convenient. Under my proposal Mrs. Rometty's status as a member and chairman of the Board of Directors would not be affected.

IMB sought exclusion of the proposal under Rule 14a-8(i)(7).

Rule 14a-8 provides shareholders with the right to insert a proposal in companies’ proxy materials 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements. In addition, the rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC.

Subsection (i)(7) permits exclusion of shareholder proposals that involve matters pertaining to “ordinary business” operations, including “management of the workforce” and “termination of employees.” This section understands “ordinary business” to mean the issues that are fundamental to a company’s management abilities on a daily basis. Ordinary business matters are a fundamental component of management’s role in effectively running the company on a daily basis, and thus are not subjected to shareholder oversight. For additional explanation of this exclusion, see Megan Livingston, The “Unordinary Business” Exclusion and Changes to Board Structure, and Adrien Anderson, The Policy of Determining Significant Policy Under Rule 14a-8(i)(7).

IMB argued Shareholder’s proposal seeks to remove the Chief Executive Officer and therefor relates to ordinary business matters involving employment policies.  In addition, as senior management, the CEO’s role included directing and overseeing the company’s operations. In the event of resignation, IMB would have difficulty finding a replacement because future office holders would not want to hold a position “micro-manage[d]” by shareholders.

In response, Shareholder urged that his proposal does not require the company to enforce CEO’s retirement. Rather, the proposal sought to provide the board with the views of shareholders on the leadership of the company. Shareholder emphasized that, if the company chose to act on the majority vote, the company could determine the timing of the CEO’s retirement.  Moreover, under the Proposal, nothing prevented the CEO from maintaining her Board position.

The SEC agreed with IBM’s reasoning, and concluded IBM may exclude Shareholder’s proposal under Rule 14a-8(i)(7). The staff noted the proposal related to ordinary business matters because it involved the “termination, hiring, or promotion of employees.”

The primary materials for this post can be found on the SEC Website

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